The precipitous outbreak of the coronavirus is presenting a frightening health crisis globally and in Australia. Human impact of this crisis is greater than ever, but there is also a significant economic impact being felt globally.
A higher level of uncertainty of these events and conditions are posing commercial risks that companies have not encountered before. Effects like loss of revenue and disrupted supply chains are challenging more and more businesses. These challenges have a direct impact on the financial reporting process and therefore on the financial statements of companies.
Directors, Boards and preparers of financial statements need to evaluate financial reporting implications of these events and respond to them in accordance with the applicable financial reporting framework.
As a result of COVID-19, we have summarised key issues and their potential impact on the financial reporting for 2020 period end (NB: This is not an exhaustive list and there may be various other issues with relevant implications on the financial reports).
Relevant liquidity and going concern considerations
Those charged with governance (TCWG) and preparers of financial statements need to consider the current and anticipated potential effects of the coronavirus on their business activities. There is no single approach as to how much consideration is required and as a result the required disclosures and conclusions reached will be different from company to company.
Given the fact that COVID-19 is a rapidly changing scenario, updates to judgements and assumptions are required on a regular basis.
Management need to assess whether these events individually or as collectively with other events, cast significant doubt on the company’s ability to continue as a going concern (if yes then this need to be disclosed in the financial report accordingly) or whether the going concern assumption is still appropriate as a basis for the preparation of the company’s financial statements (if not the financial statements need to prepared on break up or liquidation basis) .
Though most companies have been impacted due to COVID-19 in one way or another, it is evident that entities in the following sectors are experiencing sharp decline in demand which is impacting their revenue and margins. These industries include entertainment and tourism, travel sports, automotive, gambling, fashion and retail and the oil industry.
Actions for management
- Risk assessment of COVID-19 events.
- Conclude whether it is adjusting or non-adjusting event.
- Assess going concern basis of preparation.
- Adequately disclose events and Its impact.
Impairment of non-financial assets
AASB 136 requires goodwill and intangible assets with indefinite lives to be tested for impairment at least annually. It also requires testing of impairment of other non-financial assets when there is an indication of possible impairment often called a triggering event.
Due to COVID-19, changes which have impacted the entity operations currently or could have impact in the future are triggering events. These include:
- an asset becoming idle, plans to discontinue or restructure the operation to which an asset belongs.
- plans to dispose of an asset before the previously expected date.
- loss of significant revenue.
Considerations for the management
- Estimation of future cash flow for impairment testing purpose due to highly uncertain environment
- Reflection of risks in the discount rates used in discounting cash flows
- Consideration of cashflow projections e.g. using expected cash flow approach than traditional approach.
- Impact on estimates like useful lives of the assets, rates of depreciation/amortisation and residual values.
Due to highly uncertain economic environment posed by COVID-19 crisis, it could be possible that management may not be able to estimate future cash flows with certainty and therefore robust disclosures will be required to understand the degree of uncertainty in estimating for example recoverable amount of the assets.
Measurement of fair values
Fair value measurements of assets and liabilities (e.g. investment properties), could be challenging due to significant change in the assumptions, market conditions (credit and liquidity risk, foreign exchange risk, commodity price risk etc.) and related inputs. Level 3 measurement or fair value measurement under unobservable inputs will be further challenging (e.g. how market participants will reflect the impact of COVID-19 and their expectations to cash flows from the respective asset or liability at the reporting date).
This uncertainty caused by COVID-19 may require detailed sensitivity analysis and disclosures along with key estimates used in arriving at the fair values
COVID-19 impact on revenue generated by companies is likely to be greater than many other areas of business. Customers may not be able to fulfill their purchase commitments due to cash flow issues, decrease in demand or simply shut down of the business. Customers may also seek to arrange changes in the existing contracts.
These changes could challenge whether revenue is still recognisable under AASB15 for the contracts for which revenue is recognised in time. And for those contracts where revenue is recognised over time, management need to assess whether the right to payment continues to be enforceable under conditions of COVID-19.
Consideration for management
- Update estimates for variable considerations such as discounts, rebates, performance bonuses.
- Review and disclose judgements effecting timing and amount of revenue recognised.
- Determine if the right to payment is still enforceable.
- Review the estimates applied e.g. observable selling price change.
As a result of COVID-19 and its impact on e.g. retail sector has already resulted in rent relief by government and rent reductions and concessions negotiated between lessors and lessees.
Lease accounting could be significantly impacted due to various factors such as rent concessions, rent reductions, modification to lease agreements such as changing fixed rent to variable rent and so on.
Preparers of financial statements may need to recalculate lease liabilities, right of use of assets and impairment of these assets as a result of review of lease contracts for rent adjustment clauses, identification of key estimates and judgements (e.g. discount rates, increase in rent percentage etc).
Government grants/assistance and tax relief
Like many governments across the globe, in Australia, Federal and State/Territory level governments have announced various forms of government grants/assistance and tax relief packages to businesses due to COVID-19.
Depending on the type of assistance/relief, the impact will be on various areas of the financial statements (e.g. leases and right to use asset if the grant or assistance is the form of rent relief, revenue and assets).
The important thing for management to analyse the impact of each type of grant and assistance individually and account for it under relevant accounting standard.
Extensive disclosures are also needed to be considered.
Expected Credit Losses (ECL):
ECL applies to trade receivables, loans, debt securities, as well as the losses recognised in measuring loan commitments and financial guarantee contracts. Incorporating forward looking information due to COVID-19 in ECLs measurement could be a challenge and may require relevant disclosures for credit risk and uncertainty on timing of future cash flows.
Valuation of inventories:
Existing difficult economic environment due to COVID-19 (like cancellation of sales contracts, significant decrease in demand, shut down of plant and machinery and thus decrease in production capacity etc), the net realisable value (NRV) calculation may need to be closely assessed at the reporting date.
Deferred tax assets:
Deferred tax assets should only be recorded when certain that they are recoverable in the future. Current scenario may impact change to future forecasts and thus recoverability of deferred tax asset needs to be assessed and adjusted accordingly.
Some other important considerations
Breach of covenants:
Unstable conditions and potential cash flow issues under current scenario may trigger breach of covenants. Management need to review their existing borrowing arrangement and may need to arrange to defer payments to keep the liability as non-current as breach may trigger the loan payable on demand and thus the classification of liability from non-current to current in the statement of financial position. (In case of breach subsequent to reporting date and as a non-adjusting event adequate disclosure need to be given in the financial report).
Provisions and unavoidable liability:
As a result of COVID-19 outbreak, challenges in supply chain, disrupted operations and cash flow challenges, contracts may become onerous if the obligations are not fulfilled. In this case provision may need to be accounted for, for the breach of contracts and penalties thereon.
Due to current scenario, termination of employees and change in remuneration and benefits is like to occur in various companies. This could impact the estimation and measurement of employee benefits including share-based payments.
Internal controls over financial reporting (ICOFR)
Apart from the above accounting considerations, the current scenario could impact the ICOFR e.g. in case where IT controls have been modified or changed to facilitate delegation/approval of transactions, allow remote working etc. Management need to reassess the effectiveness of these controls and impact on the financial reporting.
Communication and continuous assessment
Companies need to have proactive communication with their boards, audit committees, external auditors, legal counsel and other key stakeholders as the situation progress.
Extensive impact assessment of COVID-19 involving quantitative and qualitative factors on the operating results, liquidity, going concern, commitments and others as noted above need to be carried out. As a result, adequate adjustments and disclosures would help companies in delivering meaningful and transparent financial reporting to the stakeholders.
Our highly skilled and qualified audit and financial reporting team at Walker Wayland Advantage can help you navigate the challenges to your risk assessment process due to COVID-19 and its impact on your financial reporting.
Awais Ur Rehman Hadyn Greer
Partner-Audit & Assurance Manager-Audit & Assurance
0403 148 629 0401 263 008